Binaries, for short, have had a parabolic rise in interest as can be seen in the Google Search Trend chart below. This is not an accident. The fact is that binaries offer a very quick and easy way to put on a trade.
Let’s quickly review some basics.
Binaries are simply a yes or no trade. If the trader believes that an underlying market (i.e., Currencies, Gold, Oil, Indexes, etc.) will be higher or lower by a certain expiration time, he will press a Buy or Sell button. In many platforms, the trading input entry button are labeed UP or DOWN, or a CALL or PUT.
Platforms offer different durations from 1 minute to End of Week. In the United States the Binary platforms offered by the North American Derivative Exchange (NADEX) and Cantor Fitzgerald (CantorExchange) are laddered binaries. This means that the trader gets to choose a price point above or below the market price. These price points are called ladders.
There are therefore two types of binaries that are being offered on a world- wide basis. The Hi-Low binaries simply require a decision on whether a market will be higher or lower against the market spot price which is the reference point. In contrast, the laddered binaries require a decision of whether the market will be above or below a specific price point by expiration.
In-effect, both binary types challenge the trader to choose a likely direction. In the Hi-Low binaries, the trader selects the size of the risk he is taking. For example, if they put on a $100 trade then the risk is $100 on a loss. The gain would be 80% of the risk. This may vary from different firms.
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For the Binary laddered types of trades, the trader selects the targeted strike price. A buyer would pay the Offer or Ask price, for example $80. That trader predicts the price will be above a targeted strike price. The reward would be a fixed $100. A seller would select a strike price that he believes would not be reached. The seller receives the Bid amount, for example $15. A win on that trade would mean the seller keeps the full amount. The risk for the seller is $100 minus the Bid.
The mechanics of the binary trade are fairly straightforward. Yet what is profoundly important may not be apparent to the casual observer.
In particular, in reference to the binary laddered type (NADEX, Cantor), because there is a fixed payout of $100, the actual premium reflects the Expected probability of reaching the target. If a trader pays $80 for a binary strike price, he knows that the maximum possible value is $100. Therefore, the $80 amount can be interpreted as representing an 80% expectation about that direction.
Think about the implications of this expectation information. If on a Monday morning a strike price is offered at $80 there is great optimism that the direction will be above that strike price at expiration. If the strike price is offered at the much lower $ 40, there is a lot of pessimism. In fact 60% of the “crowd” of traders is bearish on the direction.
This means that in many ways, trading binaries is a decision on trading with or against the crowd.
In this age of the internet, information is mixed with rumors and hyperbole and it is transmitted instantly around the world. The result creates swarm behavior in markets. The result is often pricing that is based on emotional reaction to the news. For example, when the Russians undertook their Crimea incursion, the first weekend of March, Gold and Oil surged. That following Monday, pricing of premiums on Gold and Oil ladders showed great pessimism in Gold and Oil weakening. In fact, those binary traders who bet on the weakening of Gold or Oil, would have made double digit returns.
The Greek debt crises provided frequent examples of a pessimism to euphoria cycle, where on a Monday the markets had maximum fear of a breakdown in talks and a Greek default, only resulting in a swing to optimism during or by the end of the week.
On Monday June 29 markets were in deep fear, resulting from a breakdown in talks. The EURUSD was at 1.11 at 4 AM. The price of the EURUSD 1.1225 weekly binary ladder was $33. Buying that ladder would be an example of a Deep Out of the Money (DOOM) position.
By 4 PM EST that Monday, the Bid registered at $49.75. This represented a return in 12 hours of 50%. Not a bad result by any standard, in particular when most traders stand aside in the face of fear.
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Let’s stop and think about the ability of binaries to detect crowd behavior and emotions. We have arrived at the key feature that makes binaries interesting and powerful– crowd sourcing. Using laddered binaries, we gain insight into the expectations about price direction. It is not a prediction of price direction, but more a metric about mass opinion.
Binaries offer another interesting feature for traders. Binaries allow traders to bet easily where the market is NOT going. For example, when markets surge or sell off in response to an economic data release, traders often find it too late to join the action, or to predict where the market will wind up.
However, binaries allow a different kind of prediction. Traders can bet that the market will NOT return to a certain point. Predicting what the market will likely not go back to, after a response to a news event provides a more likely set of profitable opportunities than predicting how much further the market will go.
How to Use Binaries to Hedge Your Portfolio
Finally, traders should not ignore the potential use of binary options for hedging their portfolios. It’s a simple approach and goal. Use binaries to get paid while your bigger portfolio is losing money.
The trader should decide how much downside risk they fear if markets correct. For example, let’s assume it’s a potential loss of $12,000 USD in the event of a sell-off. By selling a Weekly Binary on the US500 (the S&P 500) at a bid of $60, if the market sells off, the trader will keep the $60.
Two hundred contracts on the US500 generate $12,000 and offset all or some of the loss. It is not a precise science, but it is worth exploring. The bottom-line is – if you have not tried binaries, you’re missing one of the most exciting and useful investment and trading instruments that has emerged in recent years.
Abe Cofnas is President of Quick Silver Concepts Inc., and Founder of Learn4x.com—one of the first firms in the world to provide web-based interactive training and coaching exclusively on Forex Trading. He is also a twenty-year trading veteran and author of “Forex Trading in the Post ’08 Era” and “The Forex Trading Course Second Edition ( Wiley, Bloomberg)”.
To learn how to get started trading binary options check out Abe’s free e-book titled Cutting Edge Binary Strategies. Click here now to download a free copy